Problem:
8. Which of the following would an auditor most likely use in determining the auditor’s preliminary judgment about materiality?
a. The anticipated sample size of the planned substantive tests.
b. The entity’s annualized interim financial statements.
c. The results of the internal control questionnaire.
d. The contents of the management representation letter.

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Answer & Explaination:
8. (b) The requirement is to identify the information that an auditor would most likely use in determining a preliminary judgment about materiality. Answer (b) is correct because many materiality measures relate to an annual figure (e.g., net income, sales). Answer (a) is incorrect because the preliminary judgment about materiality is a factor used in determining the anticipated sample size, not the reverse as suggested by the reply. Answers (c) and (d) are incorrect because materiality will not normally be affected by the results of the internal control questionnaire or the contents of the management representation letters.

Problem:
9. Which of the following statements is not correct about materiality?
a. The concept of materiality recognizes that some matters are important for fair presentation of financial statements in conformity with GAAP, while other matters are not important.
b. An auditor considers materiality for planning purposes in terms of the largest aggregate level of misstatements that could be material to any one of the financial statements.
c. Materiality judgments are made in light of surrounding circumstances and necessarily involve both quantitative and qualitative judgments.
d. An auditor’s consideration of materiality is influenced by the auditor’s perception of the needs of a reasonable person who will rely on the financial statements.

Answer & Explaination:
9. (b) The requirement is to identify the statement that is not correct concerning materiality. Answer (b) is the proper reply because the auditor considers materiality for planning purposes in terms of the smallest, not the largest, aggregate amount of misstatement that could be material to any one of the financial statements. Answers (a), (c), and (d) all represent correct statements about materiality.

Problem:
10. Which of the following elements underlies the application of generally accepted auditing standards, particularly the standards of fieldwork and reporting?
a. Internal control.
b. Corroborating evidence.
c. Quality control.
d. Materiality and relative risk.

Answer & Explaination:
10. (d) The requirement is to identify the elements which underlie the application of generally accepted auditing standards, particularly the standards of fieldwork and reporting. Answer (d) is correct because AU 150 states that materiality and relative risk underlie the application of all the standards. Answer (a) is incorrect because a consideration of internal control is one of the field standards, not an element underlying the standards. Answer (b) is incorrect because the second fieldwork standard, on evidence, relates most directly to corroborating evidence. Answer (c) is incorrect because while it is accurate that quality control standards encompass the firm’s policies and procedures to provide reasonable assurance of conforming with professional standards, the standards are not related more directly to the fieldwork and reporting standards than to the general group of generally accepted auditing standards.

Problem:
11. In considering materiality for planning purposes, an auditor believes that misstatements aggregating $10,000 would have a material effect on an entity’s income statement, but that misstatements would have to aggregate $20,000 to materially affect the balance sheet. Ordinarily, it would be appropriate to design auditing procedures that would be expected to detect misstatements that aggregate
a. $10,000
b. $15,000
c. $20,000
d. $30,000

Answer & Explaination:
11. (a) The requirement is to determine the appropriate level of materiality for planning purposes when $10,000 would have a material effect on an entity’s income statement, but $20,000 would materially affect the balance sheet. AU 312 states that the audit should be designed to obtain reasonable assurance about whether the financial statements are free of material misstatement. Because it will ordinarily be difficult to anticipate during the planning stage of an audit whether all misstatements will affect only one financial statement, the auditor is generally required to use the lower financial statement figure for most portions of planning. Therefore, answer (a), $10,000, is correct. Answers (b), (c), and (d) are all incorrect because they are dollar amounts which exceed the lowest level of materiality.

Problem:
12. Which of the following would an auditor most likely use in determining the auditor’s preliminary judgment about materiality?
a. The results of the initial assessment of control risk.
b. The anticipated sample size for planned substantive tests.
c. The entity’s financial statements of the prior year.
d. The assertions that are embodied in the financial statements.

Answer & Explaination:
12. (c) The requirement is to identify the information that an auditor would be most likely to use in making a preliminary judgment about materiality. Answer (c) is correct because auditors often choose to use a measure relating to the prior year’s financial statements (e.g., a percentage of total assets, net income, or revenue) to arrive at a preliminary judgment about materiality. Answer (a) is incorrect because materiality is based on the magnitude of an omission or misstatement and not on the initial assessment of control risk. Answer (b) is incorrect because while an auditor’s materiality judgment will affect the anticipated sample size for planned substantive tests, sample size does not affect the materiality judgment. Answer (d) is incorrect because the assertions embodied in the financial statements remain the same from one audit to another. See AU 312 for information on materiality and AU 326 for information on financial statement assertions.

Problem:
13. Holding other planning considerations equal, a decrease in the amount of misstatement in a class of transactions that an auditor could tolerate most likely would cause the auditor to
a. Apply the planned substantive tests prior to the balance sheet date.
b. Perform the planned auditing procedures closer to the balance sheet date.
c. Increase the assessed level of control risk for relevant financial statement assertions.
d. Decrease the extent of auditing procedures to be applied to the class of transactions.

Answer & Explaination:
13. (b) The requirement is to identify the most likely effect of a decrease in the tolerable amount of misstatement (tolerable misstatement) in a class of transactions. Answer (b) is correct because AU 312 states that decreasing the tolerable amount of misstatement will require the auditor to do one or more of the following: (1) perform auditing procedures closer to the balance sheet date (answer [b]); (2) select a more effective auditing procedure; or (3) increase the extent of a particular auditing procedure. Answer (a) is incorrect because in such a circumstance substantive tests are more likely to be performed at or after the balance sheet date than prior to the balance sheet date. Answer (c) is incorrect because decreasing the tolerable amount of misstatement will not necessarily lead to an increase in the assessed level of control risk. Answer (d) is incorrect because the extent of auditing procedures will be increased, not decreased.

Problem:
14. When issuing an unqualified opinion, the auditor who evaluates the audit findings should be satisfied that the
a. Amount of known misstatement is documented in the management representation letter.
b. Estimate of the total likely misstatement is less than a material amount.
c. Amount of known misstatement is acknowledged and recorded by the client.
d. Estimate of the total likely misstatement includes the adjusting entries already recorded by the client.

Answer & Explaination:
14. (b) The requirement is to identify the necessary condition for an auditor to be able to issue an unqualified opinion. Answer (b) is correct because if the estimate of likely misstatement is equal to or greater than a material amount a material departure from generally accepted accounting principles exists and thus AU 508 requires either a qualified or adverse opinion in such circumstances. Answer (a) is incorrect because the amount of known misstatement (if any) need not be documented in the management representation letter. Answer (c) is incorrect because it ordinarily is not necessary for the client to acknowledge and record immaterial known misstatements. Answer (d) is incorrect because the total likely misstatement need not include the adjusting entries already recorded by the client. See AU 312 for guidance on the evaluation of audit findings involving misstatements.